Tuesday 5 June 2012 15.42 EDT
First published on Tuesday 5 June 2012 15.42 EDT

The European Central Bank will come under renewed pressure on Wednesday to take new steps to stimulate Europe's flatlining economy as economic surveys show that the eurozone is shrinking.

On another tough day for the eurozone, data from Markit showed that the output of Europe's private economy shrank at its fastest rate in nearly three years in May. Retail spending across the eurozone also fell much faster than forecast, with sales down by 1% in April compared with March, and 2.5% lower year-on-year. German industrial orders dropped by 1.9% in April, driven by a slump in overseas business.

The news came as Spain admitted for the first time that it needs outside help to recapitalise its banks, but continued to resist seeking a formal bailout.

Economists said the dire data indicated that eurozone GDP will fall by as much as 0.5% in the current quarter, after stagnating in the first three months of 2012.

"Companies report business activity to have been hit by heightened political and economic uncertainty, which has exacerbated already weak demand both in the euro area and further afield," said Chris Williamson of Markit.

Spain and Italy, the two countries battling to retain the confidence of the financial markets, saw the largest drops in private sector output as their austerity programmes continued to bite.

Jeremy Cook, chief economist at World First, said: "PMIs this morning from Europe confirmed what has become very evident of late; that the situation in Europe will get a lot worse before it gets better."

The bleak outlook in the eurozone will weigh on traders in London, as they return to their desks after the four-day break to mark the Queen's diamond jubilee. All eyes will be on the City to see how shares respond. There was little prospect of a rally on Tuesday night with the futures market predicting a 18-point fall on the FTSE 100, partly due to a number of stocks going 'ex-dividend'.

The ECB general council will announce its decision on monetary policy at lunchtime after its monthly meeting in Frankfurt. It will also release its latest economic projections for this year and 2013, which are likely to paint a more downbeat picture.

Despite the mounting evidence that the European economy is in trouble, a majority of economists believe the ECB will vote to leave interest rates unchanged at 1% this month. The ECB has repeatedly argued that national governments must make the fiscal reforms needed to calm the crisis. But rates are still expected to fall soon.

"We doubt that the ECB will cut interest rates as soon as their June policy meeting on Wednesday – although it is not inconceivable given the Eurozone's heightened economic and sovereign debt problems – but we do now think it is highly likely that the ECB will cut interest rates to 0.75% in the third quarter," said Howard Archer of IHS Global Insight.

Christine Lagarde, head of the International Monetary Fund, added to the pressure on the ECB by saying it has room to cut rates.

With Spanish bond yields close to the "danger zone", and Italy not far behind, the ECB is also facing calls to start buying both country's debt in the bond markets again.

European stock markets experienced a mixed day on Tuesday. France's CAC index ended 1% higher, but Germany's DAX closed down 8 points at 5969, and the main Athens index fell more than 5% to a fresh 22-year low.

European markets will remain highly nervous until the deadlock over Spain's banking crisis is resolved. Madrid's government continues to resist pressure to seek a bailout, but many analysts believe its resolve must crack.

Germany's governing Christian Democrats, and the opposition Social Democrats, are both adamant that EU rules cannot be bent for Spain. Volker Kauder, the CDU's parliamentary leader in Berlin, said financial aid for Spain must be requested by the government itself.

Frank-Walter Steinmeier, former German foreign minister and current SPD parliamentary leader, took a stronger line, saying there was a risk that Spain could run out of time. "I see a risk that Spain will be too late in deciding to seek protection from the euro rescue umbrella," Steinmeier said.